Steel Stocks Starting to Show Their Mettle

Play options in NUE, the best of a lagging bunch

Steel stocks — which have been plagued by relative weakness in the basic material sector as well as the broader commodity complex — have had little to brag about this year. While the S&P 500 Index is up 15% year-to-date, the Market Vectors Steel ETF (NYSE:SLX) is down 12%.

And yet, with the recent rotation back into offensive sectors like technology, industrials and basic materials, many steel stocks have established fairly convincing bottoming patterns.

Click to Enlarge Since plumbing a new 52-week low at $39.37 in mid-April, the SLX has generated a hat trick of bullish signals.

With the development of a higher pivot low and subsequent break of resistance, the steel fund has completed and confirmed an inverted head-and-shoulders pattern. By adding the height of the pattern to the breakout point, we obtain an upside target of approximately $46.25.

The bulls scored yet another victory by pushing SLX back above its 50-day moving average (blue line in chart) for the first time since its high-volume breakdown in mid-February. The 50-day MA is used by many technicians as an indicator of the intermediate trend. While it would be even better if this key average were rising instead of falling, the fact the SLX was finally able to climb back above it is a step in the right direction.

Our final bullish signal comes from the popular momentum indicator — the RSI. During a bull market dips in the RSI typically find support in the 50 zone. Alternatively, in bear markets rallies in the RSI typically find resistance in the 50 zone. Since the aforementioned mid-February breakdown in SLX, the RSI has been firmly entrenched in bear territory. Until last week, that is. The recent surge in steel was sufficient to pull the RSI back above resistance and firmly into the bull zone.

Click to Enlarge One of the better-looking players in the steel space is Nucor (NYSE:NUE). Compared to SLX’s decline of 12%, the year-to-date 4% gain in NUE looks outright stellar. Thus, if you believe the recent resurrection in steel is the real deal, the three-day pullback in NUE might be setting up a decent low-risk entry point for bullish strategies.

One higher-probability play worth considering is selling the June 44 put for 90 cents. The max reward is limited to the initial 90 cents received and will be captured if NUE can remain above $44 by June expiration.

A viable exit strategy is to exit if NUE breaks back below its 200-day moving average at $42.50, which should limit your loss to less than $150.

As of this writing, Tyler Craig did not hold a position in any of the aforementioned securities.